The Employee Retention Tax Credit, or "ERTC," is being marketed as the greatest thing since sliced bread. I know this because I still receive weekly calls from "experts" telling me to act now and claim thousands of dollars in tax credits before it's too late.
In fact, there has been so much interest in the ERTC that the IRS has officially stopped processing requests.
While that doesn't mean the well for these tax credit dollars has run dry, it certainly appears the government has caught on to this frenzy and is on high alert for potential fraudulent applications. And perhaps more importantly, you may still have time to apply on behalf of your business or nonprofit.
For those who aren't familiar with the ERTC, or who've heard the term before but aren't sure if they're eligible, here's a primer to help get you started.
What is the ERTC
Born out of the pandemic, the ERTC was introduced as part of the CARES Act and is designed to incentivize businesses to retain employees during times of economic hardship in exchange for a financial reward in the form of a tax credit.
To illustrate, let's say your business or nonprofit employs 10 workers all of whom you kept on the payroll during 2020 despite a significant decline in revenue. If your business met certain eligibility requirements (more on this later) and you correctly filed the necessary paperwork, the federal government would mail you a check. Pretty sweet deal.
The ERTC rules and criteria have changed significantly since the CARES Act was signed into law and, since November 21, 2021 when the Infrastructure Investment and Jobs Act was passed, businesses can no longer claim the credit for wages paid after September 30, 2021.
Despite post Q4 2021 wages being ineligible, businesses and nonprofits can still amend prior years' tax returns for 2020 and 2021 to claim the ETRC. And though the IRS put a hold on processing new applications, the hold isn't permanent and may in fact be lifted January 1, 2024.
If that's the case, those who haven't filed for the tax credit should consider learning more about the eligibility criteria for claiming the ERTC.
Eligibility Criteria
Let's first start with the ERTC for the tax year 2020 which is equal to 50% of up to $10,000 of qualified wages (defined later) paid to employees from March 13, 2020 through December 31, 2020.
Before I list the criteria, let me save the sole-proprietors filing a Schedule C some time: You are NOT eligible! If you didn't employ paid workers in 2020 or 2021, ignore the rest of this post.
Businesses with fewer than 500 full-time employees (for larger businesses, certain limitations apply) are able to claim the 2020 ERTC for wages paid from March 13, 2020 to December 31, 2020 if they met any one of the following criteria:
Your business was fully or partially suspended due to government orders resulting from COVID-19.
You experienced a significant decline (defined as 50% or more) in quarterly gross sales from 2019 to 2021. Example: Q2 2021 sales dropped to $250,000 from $500,000 in Q2 2019.
Like almost any tax law placed into order, there are exceptions to the rule.
The first exception relates to 1 above and involves the definition of "partial suspension." You can't just say your business was interrupted in 2020 due to COVID-19 and claim the credit. You have to be able to prove that a partial suspension, where a nominal part of your business was negatively impacted, resulted in at least a 10% reduction in your company's ability to provide goods and services.
On top of that, if your employees were able to work fully remote and day-to-day business operations continued as usual, you don't qualify under the definition of “partial suspension.”
Another exception relates to 2 (significant decline in gross receipts) and states that a business no longer qualifies for the credit in the quarter after the quarter where gross sales were more than 80% of the same quarter in 2019. Example: Gross sales were $100,000 per quarter in 2019. Q2 2020 sales were $48,000, Q3 2020 $81,000 and Q4 2020 $77,000. Under this exception, the business would qualify for the ERTC Q2 and Q3 of 2020 but not Q4.
If those criteria weren't confusing enough, the rules changed for 2021:
Businesses with less than 500 full-time employees (for larger businesses, certain limitations apply) are able to claim the 2021 ERTC for gross wages paid from January 1, 2021 through September 30, 2021 if they met any one of the following criteria:
Your business was fully or partially suspended due to government orders resulting from COVID-19. This is consistent with the 2020 rules, however the world all but opened back up in 2021, meaning it may be harder to qualify without definitive proof.
You experienced a significant decline (defined as 20% or more) in quarterly gross sales from 2019 to 2020. Example: Q2 2021 sales dropped to $400,000 from $500,000 in Q2 2019.
Other than the change from 50% to 20% decline in gross sales, the other major change in eligibility from 2020 to 2021 is what's called the Alternative Quarter Election Rule.
Under the Alternative Quarter Election Rule, an employer can look to the previous quarter of gross sales to compare to the same calendar quarter in 2019 to determine if there was a 20% or more decline in revenue. Example: 2019 quarterly sales were $100,000. Q1 2021 sales were $66,000, Q2 2021 $91,000 and Q3 $69,000. Even though Q2 2021 quarterly sales didn't decline by 20% or more than Q2 2019, the Alternative Quarter Election Rule allows the business owner to look back to the prior quarter, which in this case was $66,000, allowing them to qualify for the ERTC for Q2.
That pretty much covers the primary areas of eligibility for claiming the credit. If you're still unsure if your business is eligible for the ERTC, or have claimed the credit and are concerned your business may not have qualified, I'd recommend consulting with a licensed tax professional.
Claiming the ERTC
If you do in fact meet the eligibility criteria, here is the process for claiming the ERTC and calculations involved:
Calculate qualified wages for the quarters eligible to claim the credit. For companies applying for the credit under full or partial suspension criteria, any wages subject to Medicare tax paid to employees during the qualifying time periods in 2020 and 2021 would be eligible for the credit up to a maximum of $10,000 per employee per quarter. For businesses with more than 100 employees, the definition of qualified wages is a bit more complicated as only amounts paid to retain an employee who is not working or providing services would qualify. This limit changed from 100 employees to 500 in 2021. Another modification to this calculation is Paycheck Protection Program (PPP) loan proceeds. Since the IRS doesn't want businesses double-dipping, any wages used in determining the amount of a PPP loan would not be included in qualified wages for the ERTC.
Once you have a qualified wages calculated, you should then amend your quarterly payroll tax filings by completing and filing Form 941-X. The form can be a bit confusing to complete correctly and you'll have to provide a written explanation regarding how your corrections were determined. I'd recommend consulting with a CPA professional to ensure the form(s) are prepared and filed correctly.
Filing 941-X forms will result in a change to your payroll expenses for that year. As such, you'll have to amend your corporate and individual tax returns for the year(s) in question.
It's now time to play the waiting game as ERTC refunds can take anywhere from two months to a year before the check is in your mailbox. With the IRS now halting new applications, I suspect any open refund checks may take a bit longer.
The last, and maybe most important step is to document everything. Maintaining accurate records and documentation of how you calculated the credit, the specific quarters in which it applies, copies of dated government orders, etc. will be crucial for IRS compliance and audit purposes.
Easy-peasy, right?
Believe me, the process for determining eligibility, making the calculations, completing and filing the necessary forms and securely documenting everything is anything but simple.
Unintended Consequences
Little did everyone know that the most significant outcome of enacting the CARES Act and ERTC wasn't tax credits for small businesses: it was the creation of a new business opportunity for scammers.
The Wall Street Journal recently published an article titled: Inside a Sales Army Turning a Tax Break Into a Modern-Day Gold Rush. Words like "cold-calling, funnel, and commissions" are mentioned in the article which conjure up scenes from Wolf of Wall Street, with hordes of screaming stock brokers pushing penny stocks to mom and pop investors.
To be fair, not everyone cold-calling small businesses that markets their ERTC services is bad. I believe that professional firms with attorneys and CPAs on staff who proactively look out for their clients' best interests should be reaching out to their eligible clients to schedule meetings and assist them with applying for the credit.
The other snake oil salesmen who call and claim your business is eligible without doing any due-diligence, say the process is easy and only takes a few minutes, or ones who require a large upfront fee for services should be avoided at all costs.
What No One is Talking About
Forget the potential for being scammed by a fast-talking broker who cons you out of a few thousand dollars in fees. This bozo should be the least of your worries.
The big concern I have is for those who've improperly claimed or calculated the ERTC without the assistance of a trusted CPA or attorney as they're at the mercy of the IRS. Believe me, you don't want to be on their radar.
This excerpt is taken directly from the IRS website:
The IRS reminds anyone who improperly claims the ERTC that they must pay it back, possibly with penalties and interest. What they mean is DEFINITELY, not possibly.
A business or tax-exempt group could find itself in a much worse cash position if it has to pay back the credit than if the credit was never claimed in the first place.
Much like the tax refund we spend before it's deposited into our account, it's likely businesses that have claimed and received the ERTC spent the money. So IF the ERTC was received erroneously, your company will have to repay the entire amount with interest.
We're all human and make mistakes. Not everyone, even the most experienced financial professional, is perfect.
So let's say the IRS does uncover an error and you receive a nasty letter threatening you with penalties. Now what?
Do you cut them a check for the balance owed?
Is the broker who sold you on the tax credit over the phone going to write letters to the IRS and provide ample support for your claim?
If a mistake was made, will their company pay for your interest and penalties?
The sheer volume of ERTC applications guided by "questionable" professionals leads me to believe errors are being made. As such, I suspect there to be a flood of tax notices with penalties coming in the near future.
The Trusted Professional
The benefit of working with a trusted tax professional is not just the proactive tenacity in working to minimize your tax bill.
The real value is in the ongoing service and support.
So if and when you receive a notice from the IRS, you can rest assured your advisor will be there for you, ready to take action on your behalf.
A good advisor will also maintain extensive documentation and support, especially for something like claiming the ERTC so that any subsequent notices the IRS sends can be easily challenged with corroborating evidence.
Lastly, professional firms that employ CPAs and attorneys have what's called "professional liability insurance." This means that if your advisor does in fact make an error that results in you incurring penalties and interest, their firm, or their insurance will cover it.
Moving Forward
As mentioned above, the IRS temporarily suspended processing ERTC applications, though the process may resume sometime early in 2024.
If you've yet to apply for the ERTC, and should processing resume soon, the filing deadlines per IRS are as follows:
Tax Year 2020 - Deadline is April 15, 2024
Tax Year 2021 - Deadline is April 15, 2025
Whether you've filed for the ERTC already or not, be certain you're working with a qualified and trusted tax professional who has your best interests at heart. Anything less than that could end up costing you dearly in the long run.
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